First an experiment for you. Cut up a piece of paper into a dollar shaped rectangle. Write 1000 “your last name”s on it (For example, 1000 Obikilis if you were me). Sign it on both sides. Take it to your nearby corner shop and offer that in exchange for a loaf of bread. If that doesn’t work take it to the next one. If it still doesn’t work, try the next one. You probably already know where this will end. Odds are no one will accept your 1000 Obikilis for anything.

Now try a second experiment. Take a N1000 note, also a piece of paper cut in a rectangle with 1000 written on it but this time backed by the government of the Federal Republic of Nigeria. Try to exchange that note for a loaf of bread at your nearby corner shop. Odds are the seller will accept it in exchange for the bread.

What is the difference between your 1000 Obikilis and the N1000? Confidence.

What really happens when you exchange that N1000 for bread is that the trader, upon seeing that N1000, believes it to have some value. He or she believes that you could only have gotten that N1000 by exchanging something of value that you had for it. Either by working somewhere and collecting your share of the value created in notes. Or by building something valuable and exchanging it for notes. Or by selling something valuable you had. Or by stealing someone else’s value. The trader also believes that he or she will be able to exchange that N1000 note they got from you for something else of relatively similar value at a later date.

What matters to the trader is not what you call the note. It doesn’t matter if you call it 3000 naira, or 10,000 wizkids, or 200,000,000,000 jazingas. What really matters is if you exchange your loaf of bread for this note today, you would be able to exchange that note for a similar loaf of bread tomorrow, or something else of similar value. Money is really just the intermediary in your trade by barter and prices, the unit on the note, in absolute terms mean nothing but are all about comparing one set of valuable stuff to a different set of valuable stuff.

Once you start to think of money from this perspective you realize why the number one goal of the CBN is price stability. Or in terms of our model the confidence that if you gave up your loaf of bread for N1000 today, you would be able to buy a similar loaf for N1000 next week, or next month, or maybe next year. The confidence that if you save your notes in a savings account, the return you get at the end will be able to buy more value than before. The confidence that if you invest those notes in a good business today, the return on that investment will be able to buy more valuable stuff than if you spent those notes today.

Low interest rates are nice. Foreign exchange stability is cool. But none of those come close to the importance of price stability, aka keeping inflation reasonably low. And the confidence that comes with it.

Why am I telling you this story? Because it is clear that for a while the CBN lost its focus on price stability and tried to do other things. Things like forex exchange price fixing and industrial and trade policy. The result is that many have lost confidence in the Naira and in the ability of the CBN to implement credible policy.  What happens when people lose confidence in one note? They switch to another they have confidence in, like the US dollar.

Seems like the favorite past time nowadays is to bash economists. More recently the fate of the naira since the  alleged float has been to….you guessed it…bash economists for getting it wrong. I’m not here to indulge you. But I do think its important, even you are not an economist, to learn. Or at least try to learn more about how economies work. Or at least how we think economies work. So here are two things which are important in understanding Nigeria’s troubles today and the path to getting out of those troubles.

 

  1. Pains from unsustainable policy

    Can you remember that game we all played with rubber-bands when we were kids? The one where you get a rubber-band and latch on a folded of paper. And then try to shoot people with it by using the rubber-band as some type of missile launcher? It was a fun game. Sometimes it actually worked and you hit the target. Most times though you just ended up with pain on your fingers.

    Think about the mechanics of pulling the rubber-band. Once you start pulling you have to let go at some point. The longer you pull, the more stress you impose on the rubber-band. The longer you pull the more painful it will be on your fingers when you let go. But you know you have to let go at some point. If you don’t the rubber-band will break and the pain will be even more.

    Unsustainable policy kind of works in that way. You have a policy that you know can’t go on forever. The policy needs to end. The longer you hang on to the policy and the longer the policy distances itself from reality, the bigger the pain will be when you eventually let go. The pain is worst when the policy ends by force.

    We have seen many of such policies in Nigeria. The most notable is the fuel subsidy fiasco. A policy that went on for so long and at such huge cost to the country. And a policy that was forced to end due to the collapse of oil prices and government revenue. Cue the pain from sharp increases in fuel prices.

    More recently we have had the fixed naira policy. A policy that was unsustainable and a policy which sooner or later had to end. We held on for 18 months with the subsequent strain on the economy. It has ended and the pain is here with the sharp adjustment of the currency on official markets.

    The morale of the story? Don’t start unsustainable policy. Don’t even start. If you started by some kind of accident then let go as soon as possible. Because the longer you wait the bigger the pain will be when you do let go, by choice or by force. Also do not use the pain from letting go as an excuse to start unsustainable policy again. That only means future pain.

  2. The transmission mechanism.

    Say you have a plant that you are responsible for. Your orders are to water the plant once a day. And for the most part you do it diligently. But then you forgot about it. You didn’t water the plant on Monday. The plant isn’t going to die. It’ll probably be fine. But then you forget on Tuesday, Wednesday, and Thursday. By Friday the plant is on its death bed.

    The point of this story is that it takes time for your actions (or inaction’s) to become visible in the plant. If you implement a policy of not watering the plant on Monday, the plant won’t immediately die that same Monday. It will take a while before the plant dies.

    The same happens in reverse. You wake up on Friday screaming “Oh my God i forgot to water the plant”. You go ahead and water it. The plant is not going to miraculously regain its verve. It will take a while from when you start watering the plant again to when the plant regains its verve.

    Policy, especially monetary policy, works just like the watering plant example. We call it the transmission mechanism. If you implement a policy today, good or bad, it takes a while for the effects of that policy to show up in the economy.

    For example, if you implement a bad policy like trying to fix your exchange rates when you are faced with external shocks, it takes a while for that bad policy to cause a recession. You will not have a case where a policy is implemented on Monday and the effects on the economy show up on Tuesday. Economies don’t work that way. The exact amount of time is uncertain and probably depends on the country and specifics. For example, some studies argue that it takes about 18 months for interest rate changes in the United States to affect inflation.

    Similarly, if you implement a good policy, like abandoning your currency peg and floating the currency, it takes a while before the effects of the policy manifest on the economy. If you float the currency today, you are not going to see an improvement tomorrow. It will probably take months. And even that depends on the other policies you implement.

 

The morale of these two lessons is that we have had bad and unsustainable currency policy for the last 18 months, and bad fuel pricing policy for more than 18 years. And now we have let go. There will be pain during the adjustment. It is inevitable. And the pain will be proportional to the amount of time we hung on, so it will be a lot. We should not expect the positives of the abandonment of bad policy to show up immediately. It will take a while. But once the adjustments end then we should be on a more sustainable growth path. Conditional on other policies being reasonable of course. We shouldn’t attempt to go back though. That just means we are pulling the unsustainable rubber-band again, with the pain that comes when we inevitably have to let go, again.

In my last post I asked a question: Brexit did something else to the Nigerian currency black market. What was it? Answer follows

What typically happens when you have an official rate exchange rate that is fixed too low by fiat is that a black market appears. The rate at the black market is usually a bit more realistic than the official rate. In certain cases, like the Nigerian case, the spread between the official and parallel rates is a lot.

However if the authorities decide to stop their fixed rate policy and allow the official rates float then both markets should converge. The official and parallel rate should get together and meet somewhere. Of course the Nigerian case is always special. Some sections are still banned from the official market but still, a float should have meant a convergence of both rates.

offblack

 

spread

We did see some convergence. The black market rates started falling and the official rates rose. We saw a slow convergence when we thought the official market was actually a float. So what did Brexit do? Brexit stopped the convergence that was happening. Brexit demonstrated that the official market wasn’t really what people thought it was. And since Brexit the convergence between the two markets hasn’t returned.

The morale of the story is that black market actually works like markets should work. It responds to news, shocks, and external conditions like every other market. It is proof that markets can work in Nigeria without the need for meddlesome politicians trying to micromanage everything.

Or maybe its just a coincidence.

The Central Bank caved a few weeks ago and dropped its naira fixing policy. According to the official announcement they were going to adopt a new floating regime with exchange rates determined by market conditions aka demand and supply. A policy shift that most, including myself, applauded. Except one guy like that who didn’t seem so thrilled. But anyway.

The market was launched on June the 20th and we all watched to see how the naira would cope with its new floating status. Because government people have a habit of saying one thing and doing another. Unfortunately, after two weeks of observation its all beginning to look a little suspicious.

Lets ignore the fact that the vice president and the minster of petroleum and a few other government people were able to predict what the new “floating” exchange rate would be more than two weeks in advance. Lets just ignore that.

A quick lesson. What do floating currencies look like? We are not the only country floating our currency so what do the others look like?

First we have South Africa, although their currency is a bit more volatile that the average. Still lots of ups and downs.

ZAR1Y

 

Then we have Kenya. Also floating. Not as volatile as the South Africans but still lots of ups and downs.

KES1Y

We can also check out the Euro which is traded and used more widely. Similar patterns. Ups and downs and all that.

EUR1Y

 

What is the morale of the story so far? If a currency is floating then it must have some volatility. It must go up and down depending on what is happening. What has happened to the naira since the float?

NGN1Y

 

Or if we zoom into the last month….

NGN1M

Yes. Look at it. You see it too. Even though the naira is allegedly floating it has been suspiciously flat. Almost as flat as before the float. Just at a new rate.

Hmmmm.

We are not the only ones who used to have a fixed exchange rate and abandoned it. Others have done that too. Maybe we can learn from these others what should happen after you abandon a currency peg and float. And also what happens if you abandon a currency peg for another currency peg.

First Egypt. They abandoned their currency peg in March but didn’t float. They claimed they floated the currency at the time but really just moved to another currency peg.
EGP

Looks familiar eh?

One the other hand we have Azerbaijan who abandoned their currency peg in December but actually moved to a float.
AZN

It is really beginning to look like the naira is in the same camp with team Egypt. The team that said they floated the currency by didn’t really do it.

But that’s not all. More evidence of foul play.

 

On June the 23rd an event happened. The event known as Brexit. Brexit was an important event because it was kind of surprising. The result of the surprise was an almost global readjustment in the relative values of many currencies.

The shock hit the British pound
GBP1M

The euro
EUR1M

The Chinese renminbi
CNY1M

The Indian rupee
INR1M

The Kenyan Shilling (a little)
KES1M

The South African rand
ZAR1M

and even the Ghana cedi
GHS1M

 

What happened to the Nigerian naira on the official inter bank market? You already know. Nothing. Not even a blip.
NGN1M
To put this in perspective, arguably the biggest currency event since the 2008 financial crisis happened and the official free floating inter bank market did not even blip.

The argument some would make is that all the international players had already left and so Nigeria was already isolated and insulated from global factors and so on. To answer that we can look at the black market. The currency market we all know and love and one we are sure is really floating. What happened to the unofficial USD exchange rate after Brexit?

usdngn

What about the British pound to naira exchange rate?
gbpngn

In case it is not clear enough you can look at the implied dollar pound exchange rate on the unofficial Nigerian black market. That is, if you sold dollars for naira on the black market in Nigeria, and then bought pounds with it also on the black market in Nigeria. Or the other way around.
usdgbpex

 

It is very clear that the Nigerian black market for currencies responded to Brexit like all other international markets did.

Q. If the black market responded to Brexit, why didn’t the inter-bank official market respond?

A. Because the official market is rigged.

Central Bank credibility balance: zero.

If you have an alternative explanation please drop a line in the comments section. All official data is from Bloomberg. Data on black market rates is the sell rate on Everdon BDC twitter feed. (I didn’t ask them before using it so please don’t use this post as an opportunity to harass them.)

Homework: Brexit did something else to the Nigerian currency black market. What was it?

I’ve been on holiday recently and while I was away Brexit happened. In case you have been living under a rock, Brexit is the decision by the UK to leave the EU. Not England getting knocked out by Iceland which is also hilarious.

I won’t pretend to be an expert on UK politics and I won’t claim to know the consequences of the vote. I find this article by Jeffrey Sachs and this by Tyler Cowen particularly interesting.

I do think there are lessons to be learned from Brexit particularly on the totalitarianism of popular opinion enhanced by social media. Politically correct positions frequently emerge with no space for discussions on alternatives. The penalties for openly going against the popular opinion are dire with dissenters associated with very negative connotations.

For example, even though there were very valid reasons for wanting to vote both leave and remain, publicly stating that you wanted to vote leave meant that you were branded a racist. To be clear there are racists, and many of them appear to prefer to leave. Although I am sure there are racists who wanted to remain too. The reality is that the decision to vote leave or remain was much more nuanced than just being a racist.

The same kind of phenomenon can be observed when discussing the Clinton v Trump choice, where declaring support for Trump means you are immediately branded as a racist and sexist moron. To be clear I’m not a Trump supporter and I am not racist or sexist although I probably wouldn’t vote for Clinton either. But again there are a lot of non-racist non-sexist reasons to want to vote for either candidate.

Or the decision to vote for GEJ or Buhari. To each side a decision to support the other candidate meant that you were quickly identified with whatever negative perceptions the choice was identified with. Again the reality is that there were lots of reasons to have supported or not supported either candidate.

The consequence of having no room for the expression of politically incorrect ideas is that people who hold such ideas don’t express them. And if they don’t express them then we don’t know that they have such ideas. And if we don’t know that they have such ideas then we can’t educate them about the consequences of those ideas. And if we can’t convince them then they vote based on those ideas anyway.
Or maybe I should just stick to economics.
For Nigeria Brexit means lots of uncertainty. Uncertainty about investment. Uncertainty about trade. Uncertainty about our attempts to finance our deficit with Eurobonds. Uncertainty about the effects on trade. A good post on all that here by Grieve Chelwa. It is important to note that the consequences of Brexit won’t happen overnight. And now that everyone has calmed down we can begin to really think about how to navigate the uncertainty. Because you know our policy makers haven’t thought about that yet.

 

 

 

The central bank finally provided details of its new foreign exchange policy which is set to kick off on Monday. Finally the currency peg is gone and, in a positive surprise to almost everyone, the price fixing is also gone.

In summary, the central bank will no longer attempt to directly fix exchange rates and will allow markets, specifically the interbank market, guide things based on the fundamentals. It will still however occasionally intervene in markets to either buy or sell foreign exchange. A necessary caveat seeing as a relatively large chunk of foreign exchange supply comes into the country via crude oil sales on behalf of the government. Its intervention will however be market driven, which basically means it will sell of buy at whatever price the market says. Practically, it will only sell to “licensed” primary FX dealers who will be allowed to bid for amounts starting from $10m and up.

To deal with volatility the central bank is pushing a futures market. This just basically means dealers will be able to lock in prices for future purchases. Typically this helps manage the risk of currecy fluctuations and should reduce volatility.

It wouldn’t be a Nigerian policy if there was no weird angle. BDCs are still banned from participating in the interbank market. The 41 items list is also still banned from the interbank market. This of course means there will still be the market segmentation and price markup in the black market. The size of the markup will depend on a lot of things though and we will have to wait to see how that plays out.

 

All in all though it is a much needed adjustment by the central bank after what has been over a year of a senseless currency peg. They of course tried to save face by claiming to have driven speculators from the market. But a look at the seven per cent change in the black market rates between when the policy change was announced and today says otherwise. We cannot also ignore the reality that the currency peg has so some extent been responsible for the big drop in manufacturing and the recession which will probably be officially confirmed once Q2 GDP numbers come out. Still better late than never.

 

Still Nigeria is not home and dry. A year ago I argued that an adjustment in fuel prices and the exchange rate would have given the country enough leeway to get out of the crisis. Sadly that ship has sailed. The country is probably already in recession. The optimism that was present, but from Nigerians and foreign investors, is gone. The idea that this government doesn’t really know what it is doing is firmly planted in the minds inception style. Finally there is still the small matter of central bank independence. The independence matters a lot because the previous exchange rate policy is but one in a series of bad policies that could have been implemented. Yes the bad exchange rate policy is gone but what guarantee is there that the FG will not strong arm the central bank to implement another from the bad list? There is an easy way to fix the independence problem but I won’t say it here.

 

What else does the FG need to do now? They need to immediately implement reforms that create investible opportunities in Nigeria. Reforms that say Nigeria is ready for business. Reforms that say bring your money to Nigeria. They probably also need to swallow their pride and get an emergence loan from the IMF. We’ve already done everything the IMF advised anyway so we might as well.

 

But at least for today we can give the central bank a round of applause for doing the right thing.

Originally appeared in premium times on June 15th, 2016

 

Nigeria has problems. Many many problems. These problems are not new to Nigeria. They are not unknown to Nigerians. They are not unique to Nigeria. We all know these problems. They are there in the way we fight corruption. There in the way we deliver justice. There in the way we organize security. There in the way we organize economic activities. There in the way we think about government. There in the way we collect and spend taxes. I could go on and on.

 

The last administration, and the one before that, was faced with these problems. To a large extent they did not tackle them. With a few exceptions, notable in the electricity sector, most of these problems were relegated to the back burner. Reforming the petroleum industry? Another day. Police reform? Another day. Tax reform? Another day.

 

It was initially easy to gloss over these problems while oil prices were high and there was money to burn. Then it wasn’t so easy. If you have big enough hands then you might be able to cover enough holes in your leaky bucket while fetching water with it. Once the holes become bigger than your hands then the bucket it really just a basket. Useless for fetching water.

 

Nigerians eager for a change in the way the country works voted for change. Many people would argue that the APC and President Buhari won the elections. The reality is that the PDP and President Jonathan lost it. The elections were much more about a referendum voting out corrupt bad leadership than it was about voting in a good one.

 

Be that as it may, a new government was voted in with optimism and a fresh mandate to change the way the country works. And what have they done so far with that mandate? To some extent we should not really be surprised at their actions. The tacit message by the APC before elections was that the only thing wrong with Nigeria was corruption. Every problem could in some way be traced to “evil” and corrupt people at the helm. All we needed was to vote good and corruption free people into power and everything will be alright.

 

This is not to say the message was completely false. In many areas just getting serious people into the right positions has proven very successful. The most notable is with the war against Boko Haram. Despite what you think about this government, the fact is they have taken Boko Haram a lot more seriously and the results are there for all to see. Unfortunately, despite the successes, the security arrangement in the country is still the proverbial basket. Blocking holes in one area has meant that water has come rushing out of others. From the south east to the Niger delta, from the middle belt to the north, security challenges are everywhere. So much so that you can probably name an armed militia in every state just waiting for valid or invalid reasons to unleash mayhem.

In some cases, they have begun. What has been the response of the government? Send more troops. Militancy in the delta? Send more troops. Biafra agitation in the south east? Send more troops. Herdsmen killing farmers? Send more troops. Of course once you send troops people die. I stand to be corrected but the Nigerian military is on track to become the single largest killer of Nigerians this year. And not for the first time. Nigeria needs serious reform in the way we think about security. Unfortunately, security reform was not deemed important enough to even make the list of future failed political promises. It is not on the agenda.

 

But at least they are fighting corruption. Some money has been recovered. More money has been frozen. Some people are on trial. The starting point for the fight against corruption has been to shine a light on the PDPs campaign finances. Which leads to the next obvious questions. What about the APCs? That question is still yet to be answered and speaks to what is really just a temporary fight against corruption.

 

Before the elections there was the general idea that fighting corruption had to come with institutional changes to the corruption fighting agencies. Ideas about merging the ICPC and the EFCC and making them financially and operationally independent from the federal government were mooted. Stripping the federal government of the power to unilaterally hire and fire the heads of these agencies were also discussed. So far these are on the list of future failed election promises. The EFCC and ICPC continue to operate under the thumbs of the president. Which means that friends of the president are fine. At least so long as they remain friends.

Unless real reform is implemented we can unfortunately expect corruption to make a grand comeback once President Buhari leaves. In fact, we should expect corruption to be worse. Some of the institutional checks and balances we had are already being broken down in the name of fighting corruption. The imaginary line we had between federal government and the NNPC is no longer imaginary. It is just not there anymore. The more important line between the federal government and the central bank is also becoming imaginary. Even though I do no doubt the honesty of President Buhari, we may not be so lucky with the next one. And the next president will have a field day if he or she chooses to be corrupt. Makes you wonder about the changes that enabled the Babangida regime to do some amazing things. Allegedly of course.

 

All those pale in comparison to the economy. The economy. The economy. The economy. No doubt the new government was dealt a tough hand. The previous government saved very little despite at least four years of extraordinarily high oil prices. A failure which they have to accept responsibility for. The previous government blames the failure to save on the state governors who fought tooth and nail to share everything. A statement which is also true. Nigerians also have to take their fair share of blame though. Reforms which may have allowed the government to save were blocked. Fight corruption not subsidy right?

 

Regardless of the hand dealt, this government has no excuses. It was common knowledge at least a year before the handover that oil prices were crashing. It was also common knowledge that Nigeria had no savings. Being dealt a bad hand just meant there was no time for trial and error or dilly dallying. Instead we had a government with no cabinet for six months and a budget that was almost a year late. To top that off we have a government that has relegated economic, and monetary, policy to a president who, with all due respect, would probably not pass an Econ 101 exam. It took an almost complete collapse of the downstream oil industry to convince the president that fuel prices are not things you can fix in your backyard at Aso Rock.

 

We all knew the president was weak on basic economics before the elections. The hope was that he would focus on his strengths and leave the rest for more competent hands. Unfortunately, that was all very hopeful. Instead we have a president who insists on being convinced about policy. This is especially the case with the nonsensical forex policy of the last year. Constitutionally the central bank does not need any kind of approval from the presidency to implement policy. However, we have a central bank governor who stands at attention anytime the president walks in the room. Ironically it was the las administration who started the fire that led to the loss of the central bank independence. But whereas they opened that door, this government has walked right into the building and set up camp.

 

The result is that we are headed for our first recession in almost a decade. All a bit sadder considering the fact that the economy was growing at about seven percent just two years ago. A year ago I might have argued that a flexible foreign exchange policy and movement on fuel prices could turn things around. Sadly the rot has already set in and it is not clear that will be enough. And as the minister of finance is finding out, there is no one coming with a stash of cash to save us.

 

The silver lining to having so many problems is that there are many things that can be done to improve the situation. No one is under any illusion that Nigeria can be turned into Sweden in four years. But the country is ripe for change and one way or the other, change must happen. The only question is if this government will start the journey there. Or if Nigerians will have to find another way.

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